June 8, 2011

World on U.S. Debt Default: ‘Frightening,’ ‘Huge Panic Globally’

China warns that a default is ‘playing with fire’

As wrangling in the U.S. Congress continues over the debt ceiling, with Republicans insisting that a taste of default could force the White House to cut spending, the rest of the world looks on in growing horror at the prospect.

Reuters reported Wednesday that government officials all over the world, as well as large creditor nations like China, are viewing the possibility as a potential disaster the more likely it gets. On Tuesday it reported that mainstream Republicans, dismissing the idea that such a move could trigger a financial catastrophe, are beginning to espouse the idea of a technical default as a means of forcing spending cuts.

While ratings agencies such as Moody's have warned of dire consequences and Wall Street has chimed in as well, the idea seems to be gathering steam, with the notion of disaster dismissed by Republicans. Countries around the world, however, particularly heavy investors in U.S. debt, are not so sanguine.

An official at India’s central bank was quoted in the report saying, “How can the U.S. be allowed to default? We don't think this is a possibility because this could then create huge panic globally.” India, which holds some $39.8 billion in U.S. Treasuries as of March, says it has not much choice regarding its investments, since U.S. debt is still considered one of the safest and most liquid. That could change if the debt limit was not raised.

Ben Westmore, a commodities economist at National Australia Bank, was quoted saying, “It has dire implications for the economy at a time when the macro data is softening. It's just a horrible idea.” Marc Ostwald, a strategist with Monument Securities in London, said the possibility was “frightening” and pointed out that bondholders would lose patience if Congress did not stop tossing about the possibility in the weeks to come. “This isn't a debate, this is like a Mexican standoff and that is where the problem lies,” he said in the report.

While many government officials and investors both inside and outside the U.S. believe the possibility is so grim that it would not be allowed to happen—Barry Evans, who oversees $83 billion in fixed income assets at Manulife Asset Management, said, “It just wouldn't

happen. They would pay their Treasury bills first instead of other bills. It's as simple as that”—others are not so sure.

China, for example, regards the possibility with extreme disfavor. The country is the U.S.'s biggest foreign creditor, holding $1.14 trillion in Treasuries as of March. Yuan Gangming, a researcher with the government think tank Chinese Academy of Social Sciences, said that default was a real risk, since Republicans “want to make things difficult for Obama ... The possibility is quite high to see a default of the U.S. debt, which would harm many countries in the world, and China in particular.” That would strain both political and economic relations between the two countries, since China would be unlikely to sit by quietly in the event of a default.

According to Li Daokui, an adviser to the People's Bank of China, a default could undermine the dollar. He added that Beijing needed to convince Washington not to proceed toward default. At a Beijing forum, Li was quoted saying, “I think there is a risk that the U.S. debt default may happen. The result will be very serious and I really hope that they would stop playing with fire.”

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